The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.

As state and local governments begin to relax their restrictions on business and individual activities, the debate has begun over what policies will best help the economy recover from the COVID-19-induced shutdown. The Tax Foundation’s General Equilibrium Model suggests that allowing businesses to immediately deduct or “expense” their capital investments in the year in which they are purchased delivers the biggest bang for the buck in spurring economic growth and jobs compared to other tax policies.

But some lawmakers worry that expensing, also known as bonus depreciation, only benefits businesses and does nothing to help workers. Indeed, there is the natural concern that since the policy is intended to incentivize capital investment it will merely lead businesses to replace workers with machines.

Academics have been investigating these issues by studying the economic effects of two short-term episodes of bonus expensing between 2002 and 2011. The consensus of these studies indicates that the fears about bonus expensing are misplaced.

These studies have found that:

expensing policies boost capital investment substantially

expensing increases employment and does not replace workers with robots

expensing policies elicit a strong response from small and medium-sized firms, especially those that are illiquid and need to improve their cash flow, and

expensing may raise wages, although the long-term effect on wages is mixed because of the temporary nature of the policy

Bonus Expensing Policies Varied Considerably Between 2002 and 2011

Federal lawmakers implemented bonus expensing twice between 2002 to 2011 to stimulate investment during economic downturns. In 2002, the second of the Bush tax cuts allowed firms to immediately expense 30 percent of their capital investments; that was later increased to 50 percent for 2003 and 2004. The policy was not renewed in 2005.

Expensing Leads to Increased Investment

In a study that analyzed how a sample of more than 120,000 firms responded to the two bonus expensing episodes, Zwick and Mahon found that the policy had a substantial impact on investment. Relative to capital assets that were not eligible for bonus expensing, firms increased their investment in eligible equipment by “10.4 percent on average between 2001 and 2004, and 16.9 percent between 2008 and 2010.” (Note that the 2002 enacting legislation included equipment purchased in the fourth quarter of 2001.)

In a separate study using the same data set, Garrett, Ohrn, and Suárez Serrato estimated that the two episodes of bonus depreciation led to $5.82 trillion of investments and 6.24 million jobs during that period. Depending on the baseline from which the overall budgetary cost is measured, they estimate that the cost-per-job created from the bonus expensing policy was between $20,000 and $50,000.

Which Firms Are Most Likely to Take Advantage of Expensing?

The Zwick and Mahon study paints an interesting portrait of the firms most likely to use, and benefit from, bonus expensing. In terms of volume, large firms claimed the largest share of bonus expensing; the top 5 percent of the firms in their sample accounted for more than 60 percent of the new investment. However, in percentage terms, small to mid-sized firms were much more responsive to the policy than large firms.

There are two explanations for this finding. First, illiquid firms were more likely to use bonus expensing than firms with a lot of cash on hand, which means that they saw the policy as a means to improve their cash flow. Second, Zwick and Mahon found that firms that had net operating losses (NOLs) did not take advantage of bonus expensing even though they would have been able to deduct those capital investments in future years when profits returned.

These results confirm the basic economic advantage of immediate expensing: a deduction today is more valuable to firms than the promise of a deduction tomorrow.

Expensing Tends to Lead to Higher Employment Levels

Some may worry that incentivizing capital investment will lead firms to replace workers with machines. However, empirical analysis of the impact of bonus expensing indicates that this did not happen during the 2002-2011 time period. Using county-level industry location data, Garrett, Ohrn, and Suárez Serrato found that bonus depreciation led to a “large and sustained effect on the level of local employment” in “locations where the cost of capital decreased the most.” Indeed, those locations saw employment increase by 2.1 percent on average over the period.

States that Conform to Federal Expensing Rules Saw Biggest Gains

Most states link their tax codes to the federal tax code in some manner. So, when Washington makes major changes to the federal tax code, states must decide if they will conform or opt out. This provides a natural experiment to see how capital investment changed in states that conform to bonus expensing compared to those that do not.

Ohrn also found that the divergent results between conforming and non-conforming states closely tracked the on-again/off-again nature of bonus expensing policies. Before bonus expensing was enacted in 2002, there was no difference in investment behavior between adopting and non-adopting states. Investment differences, however, began in 2002 and widened when bonus expensing was increased in 2003 to 50 percent. The investment gap between the states narrowed again after bonus expensing expired in 2005, but sharply increased again in 2008 when it was reinstated. Ohrn found the largest divergence in 2011 when it was expanded to 100 percent. But the investment gap closed again when bonus depreciation was scaled back in 2012.

Interestingly, Ohrn found that Section 179 expensing was used most by firms that do less investing in capital equipment, most likely because Section 179 is aimed at small businesses. By contrast, bonus expensing was concentrated in firms that do more capital investment. As Zwick and Mahon determined, the larger firms do the bulk of the capital purchases.

Conclusion

Academic analysis of the two episodes of bonus expensing between 2002 and 2011 confirm that allowing businesses to immediately deduct the cost of their capital purchases will spur new investment and jobs and aid firms that need help with cash flow. However, these results also illustrate how short-term policies fail to deliver sustained benefits and make us wonder if bonus expensing would have led to higher wage growth had it been made permanent when it was first enacted in 2002.

This research should provide a lesson for lawmakers as they consider policies to help the economy recover from the COVID-19 shutdown. Permanent policies produce permanent results. The full-expensing provisions enacted in the Tax Cuts and Jobs Act in 2017 will begin to phase out in 2022 and should be made permanent to incentivize the kind of long-term investment workers and the economy need to thrive. Lawmakers should also consider expanding expensing to buildings and factories. After all, if there are clear economic benefits to allowing firms to expense the machinery in a factory, there is no reason not to expense the factory too.

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The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.